An extremist, not a fanatic

February 13, 2017

Paul raises an important issue: what’s wrong with experts? I suspect the answer is: plenty.

These many faults, however, don’t include the failure to foresee the financial crisis. It’s not the job of economists to act as soothsayers, any more than we expect mechanics to predict the next fault with our car, or doctors our next illness. There’s a lot of good economists can do without prophecy.

Instead, one problem is that experts – in public at least – don’t sufficiently identify what Charlie Munger called the edge of their competence: they don’t say what they don’t know. The problem with economists isn’t so much that they didn’t foresee the crisis as that they failed to tell the public that recessions are unforecastable (at least by mainstream techniques?) In 2000, Prakash Loungani reported that the economic consensus had failed to predict almost every recession, and AFAIK, not much has changed since.

Of course, there’s nothing unusual about economists in this regard. Gerd Gigerenzer said that doctors are “often wrong but never in doubt”; bosses rarely openly discuss the limits on their ability to control business; bankers don’t often admit to being unable to manage risk; fund managers don’t publicly say that markets are largely efficient; and so on.

I fear that academics’ pressure to publish exacerbates this error. As Andrew Gelman has consistently argued, the “p<0.05=result!” mentality has given us a lot of bad science. This can weaken public confidence. One recent example of this is the claim that roast potatoes cause cancer. This ran into the common-sense problem that everybody eats roasties but only a few get cancer, which tells us that the link, if any, must be weak. It’s this sort of thing that generates the sentiment “Experts – what do they know?”

In this context, we should remember a point made by William Easterly – that “experts are as prone to cognitive biases as the rest of us”. One of these is overconfidence. Another is that groupthink can generate intellectual fashions, such as perhaps the dominance of DSGE models.

Perhaps another facet of this overconfidence is the presumption that knowledge and expertise must be centralized, within a single mind. But as Hayek pointed out, in some contexts this is not the case. Instead, knowledge can be fragmentary, tacit and dispersed. Consumers, for example, might be better economic forecasters than the experts – as might bondmarkets. And workers might sometimes know more than bosses.

Which brings us to a big problem. We are too often given the impression that experts are on the side of power. In part, this is the fault of the media: bosses, for example, are routinely presented as a priestly elite rather than as mere rent-seekers.

But the fault also lies with experts themselves. Economists fail to stress sufficiently that some of the settled findings of their discipline undermine claims to power. For example, the efficient markets hypothesis tells us that fund managers are charlatans; the prevalence of diseconomies of scale suggests that bosses aren’t as much in control as they pretend; and public choice economics warns us that those in power are often just rent-seekers.

In this context, even an otherwise admirable empiricism can be reactionary. Studying the effects of the small actual and feasible tweaks to capitalism means the question of big changes gets marginalized. In this way, as Paul says, economists unwittingly accept capitalist realism (pdf).

Related, to this, mainstream economists have been insufficiently awake to distributional issues. The default ethical criterion in economics is Pareto efficiency. So, for example, we’ve accepted globalization because it is potentially Pareto efficient: the gains from it to western economies are bigger than the losses. This has blinded us to the fact that a potential Pareto improvement in which the losers don’t in fact get compensation is a much more dubious matter.

If economists had a different default mental model, they’d have been better able to press the case for policies that really do benefit everybody. If economists used Rawls’ difference principle – which stresses the need for policies and institutions that “are to be to the greatest benefit of the least advantaged members of society” – they’d be much more conscious of inequality.

We all know that a gap has emerged between experts and the public – expressed in that heckle, “That’s your bloody GDP. Not ours.” If the quality of public discourse is to be lifted out of the gutter, this gap must close. At least part of the onus on doing so lies with the experts themselves.

February 10, 2017

The FT says the government’s decision to sell off some student loans “makes no sense.” From one perspective, this is true: it’s daft to sell an asset that probably has a positive return in order to pay off debt that carries a negative real interest rate. From another perspective, however, there is a kind of logic to it.

One key function of the state is to help maintain capitalist profitability. This isn’t simply because the state is the executive committee of the bourgeoisie. It’s because decent public services require a healthy economy, which in a capitalist economy requires profits to be high enough to finance and encourage investment.

But here’s the problem. In our era of stagnation, profitable opportunities are lacking. This is why business investment has been weak since the late 90s; why banks invested in mortgage derivatives rather than proper assets; and why we are bombarded with calls from people claiming to sell us compensation for PPI mis-selling or accidents we’ve not had. When real investment opportunities are lacking, we get stagnation and malinvestments.

Quite why this should be is a big question: some say it’s because profits have fallen (pdf); others because risk (pdf) has increased.

Whatever the reason, there’s a need for state action to support profits.

One way it can do this is to sell off profitable assets it owns such as council buildings or student loan books. It’s probably better for macroeconomic stability that banks make money by ripping off students than that they chase risk like they did in the mid-00s.

Another trick is to outsource – giving private firms cash to collude with criminals, miscalculate tax credits, build schools that fall down and, I suppose, occasionally do something useful. Although outsourcing companies’ share prices have fallen recently, most of them have generated lots of cash.

I say this because I suspect that what we have here is another example of something I mentioned recently – a tendency for our economic views to be shaped by our formative years as well as by present reality. Because capitalism was dynamic back in the 80s and 90s, we tend to over-rate its dynamism now. As a result, we under-rate the extent to which it needs state aid to generate profits. Privatization and outsourcing are means of doing this.

You might object here that there are more intelligent ways for the state to expand profit opportunities – for example by expansionary fiscal policy, stopping Brexit or state support for innovation.

Such options are ruled out for political reasons: what we have here is an example of the relative autonomy of the state. Even if they weren't, however, they would have limits from a capitalist point of view. Fiscal expansion might eventually generate wage militancy; stopping Brexit might create a populist backlash and hence instability; and innovation would increase creative destruction and hence threats to incumbent firms. This creates a space for cronyism such as outsourcing and privatization.

Such policies might not always make sense from a conventional point of view. But then, the logic of capitalism isn’t necessarily rational from other perspectives.

February 09, 2017

Amber Rudd says she’s stopping child refugees entering the country because “we do not want to incentivise perilous journeys to Europe particularly by the most vulnerable children.” This should remind us of an old trick of the Tory party – the ideological misuse of the language of incentives to justify their own prejudices.

For example, we’ve been told for years that the rich need high pay and low taxes to incentivize effort. This, though, is deeply doubtful. Financial incentives can crowd out intrinsic motivations: bankers’ serial criminality (rigging Libor and FX markets; PPI mis-selling; and so on) suggests that bonuses crowded out professional ethics. They can encourage short-termism or cooking the books. They can discouragecreativity (pdf). They can worsenperformance by over-motivating people. And they can create inefficiencies by encouraging (pdf) workers to focus upon jobs that are easily monitored to the detriment of other important tasks – as when teachers teach to the test.

One simple fact should tell us that all these adverse effects can add up: that the UK’s GDP growth rate has been worse in the 28 years since Nigella’s dad cut top tax rates in 1988 than it was in the previous 28 – 1.5% against 2.5%.

At the same time as telling us that the rich need big carrots, the right has long told us that the poor needed sticks in the form of welfare reform to incentivize them to get jobs. This claimtoo is doubtful. To a large extent, it is job opportunities that get people into work, not benefit reform.

A scientific assessment of incentives requires careful analysis of tricky questions: how do income and substitution effects net out – a matter which differs from worker to worker? What margins of adjustment do people have? What are their information sets: do they know what options they have? And so on.

Tories, however, neglect such issues. They know – regardless of facts – that the rich need carrots and the poor need sticks. As George Carlin said:

Conservatives say if you don’t give the rich more money, they will lose their incentive to invest. As for the poor, they tell us they’ve lost all incentive because we’ve given them too much money.

All we’re seeing in Rudd’s lamentable words is an extension of this mindset to Syrian children. Talk of incentives merely provides a pseudo-scientific justification for small-minded bigotry.

February 08, 2017

Our perceptions of the economy are shaped not just by current reality but also by the past. For example, Ulrike Malmendier and Stefan Nagel have shown (pdf) that people who experienced recessions in their formative years are more risk-averse than others even decades later; workers in the 1950s accepted low wage rises despite a tight labour market because they were cowed by memories of the Great Depression; and I struggled to believe that inflation could stay low in the 90s because my views were shaped by memories of the high inflation of the 1970s.

I suspect a similar motive lies behind the notion that the government must reduce its borrowing soon. Such a view makes sense if you think highish real interest rates are normal – as they were in our formative years. But it’s not so sensible when rates are negative.

20 year index-linked gilt yields are now minus 1.6 per cent. This means that if the government borrows £100 now it will have to repay only £72 in real terms. Which of course means that debt can shrink even if the government runs a deficit today. The maths of debt sustainability tells us that we can stabilize the current ratio of government debt to GDP even if the government runs a primary deficit (borrowing excluding interest payments) of around 2.9% of GDP. Its deficit this year will be only 1.1%, according to the OBR.

Richard Murphy is therefore right: there is no need for the government to balance its budget and no need for the forthcoming austerity described by the IFS.

Two counter-arguments to this won’t do.

One is that I’ve assumed gilts yields stay low, which they mightn’t do.

True, yields could rise – as the IFS says. But the government has to a large extent locked in lowish rates because it has borrowed long; the average maturity of government debt is 18 years. This means higher yields won’t immediately gravely raise debt interest payments. Also, yields are most likely to rise if the global economy proves stronger than expected. But the same stronger activity that raises yields would quite probably also raise tax revenues.

A second argument is that higher government borrowing would raise inflation by strengthening the economy. This, though, is a feature not a bug. We want to get interest rates away from their zero bound, so that conventional monetary policy can act as a cushion when the next downturn comes. Higher inflation is a way to achieve this. There is a strongish case for the macroeconomic policy mix shifting to looser fiscal and tighter monetary policy.

None of this is to say that fiscal policy should never tighten. It should, when real interest rates are at more “normal” levels. When this is the case, there’ll be a case for budget surpluses both to stabilize the debt-GDP ratio and to prevent a tightening of monetary policy that pushes rates very high.

Obviously, we are not yet at this stage. Fiscal tightening should thus be delayed.

Such a delay should be used wisely. We should regard it as a chance to better organize the public finances – to ask what sort of tax base we want; what should be the mix of tax rises and spending cuts; and how to find genuine efficiency savings in the public sector – a question which of course requires a knowledge of ground truth which only workers themselves can provide. If such a debate helps to legitimate austerity, it would also help make it more credible and sustainable.

If we had an intelligent politics – which is a big if – a delayed fiscal tightening would be a better tightening.

February 07, 2017

Nick Cohen makes a good point: it is not congenital liars that should worry us, but congenital believers – those who fall for the lies of charlatans. We know that many do so: almost half of voters believed the lie that leaving the EU would allow us to spend an extra £350m a week on the NHS.

This poses the question: why do people fall for lies? Here, we can learn from behavioural economics and research (pdf) into criminal fraud. I reckon there are several factors that liars exploit in politics.

One is wishful thinking. People want to believe there’s a simple solution to NHS underfunding (leave the EU!) or to low wages (cut immigration!) just as they want to believe they can get rich quick or make money by taking no risk: Ponzi schemers like Bernie Madoff play upon that last one. The wish is often the father to the belief.

Relatedly, perhaps, there are lottery-type preferences. People like long-odds bets and pay too much for them: this is why they back longshots (pdf) too much and pay over the odds for speculative shares. To such people, the fact that an offer seems too good to be true is therefore, paradoxically, tempting. A study of fraud by the OFT found:

Some people viewed responding to a scam as taking a long-odds gamble: they recognised that there was something wrong with the offer, but the size of the possible prize or reward (relative to the initial outlay) induced them to give it a try on the off-chance that it might be genuine.

There’s a particular type that is especially likely to take a long-odds bet: the desperate. Lonely people are vulnerable to the romance scam; gamblers who have lost take big bets to get even; losing teams try “hail Mary” tactics. In like fashion, people who feel like they have lost out in the era of globalization were tempted to vote for Trump and Brexit.

There’s another mechanism here: people are likely to turn to con-men if the alternatives have failed. Werner Troesken shows (pdf) how snake-oil sellers exploited this. They invested a lot in advertising and in product differentiation and so when other products failed they could claim that theirs would work when the others hadn’t. I suspect that fund managers use a similar trick: the failure of many to beat the market leads investors simply to trust others rather than tracker funds. The fact that previous policies had failed working people thus encouraged them to try something different – be it Brexit or Trump.

Yet another trick here is the affinity fraud. We tend to trust people like ourselves, or who at least who look like ourselves. Farage’s endless posturing as a “man of the people” – fag and pint in hand, not caring about “political correctness” – laid the basis for people to trust him, just as Bernie Madoff joined all the right clubs to encourage wealthy (often Jewish) folk to trust him. By contrast, the claims from the Treasury and various think-tanks that Brexit would make us poorer came from metropolitan elites who were so different from poorer working class people that they weren’t trusted. And in fact the very talk of "liberal elites" carried the subtext: "don't trust them: they're not like you".

All of these tendencies have been reinforced by another – the fact that, as David Leiser and Zeev Kril have shown, people are bad at making connections in economics. The idea that Brexit would hurt us rested upon tricky connections: between the terms of Brexit and trade rules; from trade rules to actual trade; and from trade to productivity. By contrast, the idea that leaving the EU would save us money was simple and easy to believe.

Now, I don’t say all this merely to be a Remoaner; complaining about liars is like a fish complaining that the water is wet. Instead, I want to point out that it is not sufficient to blame the BBC for not calling out Brexiters’ lies. Yes, the BBC disgraced itself during the plebiscite campaign. But we must also understand how voters fall for such mendacity. As Akerlof and Shiller write:

Voters are phishable in two major ways. First, they are not fully informed; they are information phools. Second, voters are also psychological phools; for example, because they respond to appeals such as lawnmower ads [a candidate seen mowing his own lawn is regarded as a man of the people] (Phishing for Phools, p 75)

All this raises a challenge for liberals. Many used to believe the truth would win out over lies in the marketplace for ideas. This is no longer true, if it ever were. Instead, the questions now are: what can we do about this? And what should we do? The two questions might well have different answers. But we can make a start by understanding how lies are sometimes believed.

February 05, 2017

As Stephen Bush points out, Labour has been calling for such a debate for the past 20 years – and we’ve been having one, insofar as the mindless drivel that passes for political discourse can be called a debate.

And it’s done Labour no good at all.

One reason for this is that the debate is largely dishonest. Rather than admit the brute fact that many people just don’t like foreigners, anti-immigrationists hide behind claims that immigrants are bad for wages or public services. Except in a few pinch points, or to a small extent, such claims are false.

Yes, we can point this out in debate. But doing so does no good. When confronted with evidence against their prior views, people don’t change their minds but instead double-down and become more entrenched in their error (pdf).

I suppose there is a reasonable debate to be had about whether discomfort about foreigners should be a basis for policy, or whether a loss of income and liberty is a price to pay to indulge such taste. But in a political-media system that selects for shrill hysteria over cool rationality, this is not the debate we’ll get.

In fact, there’s a positive reason not to want a debate about immigration. Ms Cooper is an economist and so should know that everything carries an opportunity cost. And the opportunity cost of debating immigration is high. Our time and cognitive bandwidth is limited, so time spent debating migration is time spent being silent about other questions.

From this perspective, debating immigration serves a reactionary function, as it silences debate about another question: is capitalism today best serving people’s interests? Debating immigration encourages the idea that immigrants are to blame for stagnant real wages and poor public services, and deflects attention from the possibility that the causes of these lie instead in secularstagnation.

What Labour should be doing therefore is demanding – and instigating – a debate about how best to increase growth, wages and living standards. We should be asking not what to do about immigration but what to do about capitalist stagnation?

Such a debate would require us to call into question the viability of conventional top-down managerialistcapitalism (pdf). Given limited cognitive bandwidth, this would deflect blame for economic failure from immigrants and help focus it elsewhere.

If you think I’m being pettily economistic in wanting a focus on pocket-book issues, you’re massively wrong. We’re re-learning today what we should have learned in the 30s and again in the 70s – that economic stagnation breeds reaction and intolerance. If you want a liberal society, you need economic growth; technocratic talk about the benefit of immigration is true, but not enough to change minds.

In fact, such a debate would serve another useful purpose. A debate about immigration brings out not just the worst in people, but the worst of people: it legitimates the reactionary drivel of Farage and Hopkins, and encourages the media to give them publicity. Shifting the debate to growth would filter out such noxious fumes: the likes of Farage have nothing worth saying about economic stagnation. Yes, it would mean hearing more from the IEA and the We’ve selectively read Wealth of Nations and ignored the Theory of Moral Sentiments Institute. But if these displace racist drivel, it’s a big improvement.

The point I’m making here is one made by Steven Lukes. Power consists, in part, in shaping the agenda – in deciding what gets debated and what doesn’t. Insofar as debating immigration means not debating the health of capitalism, it plays into the hands of the powerful.

February 02, 2017

On Radio 4’s Media Show yesterday Andrea Catherwood told Sarah Sands, the incoming editor of the Today programme:

The job specification did say that there was a requirement of extensive experience of broadcast journalism and a sound appreciation of studio broadcast techniques. You obviously got over that hurdle (16’23” in).

Many of us, though, wouldn’t even have tried the hurdle. If I’d had Ms Sands otherwise decent CV, I’d have looked at that job spec and ruled myself out as unqualified. Ms Sands, obviously, did not.

In this, she’s following many others. Tristram Hunt has become head of the V&A despite no experience of curating or of running large organizations. David Cameron wanted to become PM because he thought he’d be “rather good” at it – a judgment which now looks dubious. And the last Labour government asked David Freud to review welfare policy even though, by his own admission, he “didn't know anything about welfare at all.”

These people have something in common: they come from families sufficiently rich to afford private schooling*. And they are not isolated instances. The Sutton Trust has repeatedly shown that people from posh backgrounds are over-represented in top professions. This is unlikely to be due solely to superior ability; people from working class backgrounds earn less than those from professional backgrounds, even controlling for qualifications and experience.

One thing that’s going on here is a difference in confidence. Coming from a posh family emboldens many people to think they can do jobs even if they lack requisite qualifications. By contrast, others get the confidence knocked out of them (16’20 in)**. As Toby Morris has brilliantly shown, apparently small differences in upbringing can over the years translate into differences not only in achievement but also in senses of entitlement.

The point is not (just) that people from working-class backgrounds suffer outright discrimination. It’s that they put themselves forward less than others, and so save hirers the bother of discriminating against them.

But why do posh people get the jobs for which they’re unqualified? One reason lies in experiments by Cameron Anderson and Sebastien Brion. They’ve shown than people mistake confidence for actual ability, and so tend to hire the irrationally overconfident – even to the point of hiring dangerousnarcissists (pdf).

A further reason is that like hires like. In part, this is because a reasonable motive has a less reasonably effect. People need to trust those they hire – especially if they are in important jobs – and we naturally tend to trust people like ourselves. What’s more, the privately educated have smooth manners and social “skills” and so fit in. “In the drawing-rooms of the great” wrote Adam Smith, “the abilities to please are more regarded than the abilities to serve.”

Herein lies an issue. In hiring Ms Sands (and no doubt many others like her) the BBC is conforming to a pattern whereby inequality perpetuates itself. This suggests that the corporation is badly placed to address what is for many of us one of the great issues of our time - the many aspects of class inequality – because it is part of the problem. And it compounds this bias by focusing upon other matters instead – for example by the incessant airtime it gives to the (Dulwich College-educated) Farage***. Bias consists not merely in what is said and reported, but in what is not – in the choice of agenda. In matters of class, the BBC is not impartial.

* This habit isn’t confined to the UK. At least one American has recently taken a top job despite having neither requisite experience nor psychological qualities.

** I’m one of those. People have often told me I should have worked in academia or on a national newspaper, but I genuinely believe I am wholly unqualified to do so, and regard myself as borderline unemployable.

*** It is odd, is it not, that people from rich families think they can become the voice of the people and are presented as outsiders challenging the establishment.